ISTANBUL/LONDON, Feb. 25 -- Sitting at his desk on ICAP Plc's dealing floor in London, iron ore broker Andy Strickland is plotting how to get business in China.

He handles so-called swaps for iron ore, allowing buyers and sellers to fix prices months in advance for single cargoes of the raw material that's essential in steelmaking.

Strickland said he aims to expand his two-man team to eight, the same size as the nearby coal desk whose brokers are busy shouting into their telephones, and handle more deals as steelmakers increasingly favor buying individual iron ore consignments instead of relying on fixed-price supply agreements.

"The potential is huge," Strickland said. "You just need a catalyst for it to reach that critical mass."

The prize for the growing band of brokers and traders handling the derivatives is the possibility that iron ore will evolve into a market rivaling the liquidity and volume of other commodities.

The iron ore market is worth about $200 billion a year, second only to crude oil, according to Credit Suisse Group AG. The swap market may grow 10-fold to 360 million metric tons annually over the next two years, said Phillip Killicoat, an iron-ore dealer at the bank in London.

Such an expansion would be a vindication for the pioneers in a market that only began in May 2008. Ray Key, global head of metal trading at Deutsche Bank AG and Kamal Naqvi, Credit Suisse's global head of investor sales, began offering swaps at the instigation of BHP Billiton Ltd, the world's largest mining company, which was dissatisfied with the way iron ore is priced.

Incredible size

"Iron ore struck us as one of the last of the true commodity markets that did not have any financial presence," said Key, who likens iron ore trading to where oil trading was in the 1980s. "Its size is just incredible."

The proportion of iron ore sold on contracts pegged to an annual price benchmark will shrink to 40 percent in five years, from 70 percent now, as accords expire and aren't renewed, according to Killicoat. Melbourne-based BHP reduced the proportion of its Western Australian ore priced using the benchmark to 54 percent in the second half, from 68 percent in January through June.

The benchmark traditionally takes effect from April 1. Asian steelmakers pushed for price cuts in 2009, the first in seven years, after the biggest slump in demand for their product since World War II.

The three largest iron ore producers - Brazil's Vale SA, London-based Rio Tinto Group and BHP - and Japanese and South Korean steelmakers agreed to a 33 percent reduction.

Growing volatility

That wasn't enough for Chinese customers. Price talks with the world's biggest steelmaking nation ended in deadlock and a benchmark wasn't officially recognized, helping to opening the market to spot cargoes.

"I don't think anyone could foretell just how dire the negotiations would become," said Key, who joined Deutsche in 2007 after five years as global head of precious metal at Morgan Stanley.

Growing price volatility also helped stoke demand for spot iron ore cargoes and swaps.

"The benchmark system is untenable in the long term," said Strickland at ICAP, the world's largest broker of transaction between banks. "Market sentiment changes on a monthly basis."

Some steelmakers aren't welcoming the trend. Customers of Japanese steelmakers wouldn't want more frequent change in raw material costs, Shoji Muneoka, Nippon Steel Corp's president and the Japan Iron and Steel Federation's chairman, said at a JISF conference last month.

'More players'

Nor has Rio matched BHP's increase in spot sales. It sold most ore priced on a benchmark in the second half of 2009, after selling about half as spot in the first half.

"Markets are dynamic, markets are moving toward a position of shorter terms," Chief Executive Officer Tom Albanese said on a conference call when Rio posted its full-year earnings on Feb 11. "A lot of that's associated with more players that are involved in the market."

For the benchmark to survive, "it will need to evolve. And again if it does not evolve it will not survive", he said.

Market freeze

Swap trading started with volumes of about 250,000 tons a month, Credit Suisse's Killicoat said. It grew to about 3 million tons by September 2008, the month Lehman Brothers Holdings Inc was declared bankrupt amid the worsening global financial crisis, at which point the market froze. Volumes have since recovered, he says.

"The tipping point will come as benchmark pricing becomes less rigid and more physical material is sold on a spot and index basis," Killicoat said.

BHP has done just that, cutting the proportion of ore sold in the second half using the annual price. It sold the rest by other means, including spot sales, CEO Marius Kloppers said in a Feb 10 conference call. Illtud Harri, a London-based spokesman for BHP, declined to say how much was sold on spot.

The swap market allows ore producers to lock in volumes and prices as they see fit, rather than being tied to a benchmark that may not reflect current demand, said Simon Overy, who works on the iron ore team with Strickland at ICAP.

The derivative enables steelmakers to hedge their main raw material, he said. ICAP declined to give the value of the trade its iron ore team is handling.

'Explosive' activity

Iron ore demand is rising as steelmakers restart blast furnaces and customers rebuild inventories. In China, spot prices have gained 49 percent in the past 12 months.

"Price activity in the iron ore spot market has been explosive during the early weeks of 2010," Citigroup Inc commodity analyst Alan Heap wrote in a Feb 2 report. Credit Suisse raised its forecast for the 2010 iron ore benchmark price, saying on Feb 4 it will rebound 50 percent to $86 a ton.

Chinese steelmakers have started contract price talks with overseas suppliers, Luo Bingsheng, vice-chairman of the China Iron & Steel Association said on Feb 9.

ICAP's Strickland said that to get more people to use swaps, their "traditional" view of the market needs to change.

"Currently there is still resistance from producers that prevents the launch of a liquid spot market in iron ore. The challenge is to change people's mindsets," he said.